Stablecoins: A Viable Alternative to Cash?

Banking is a sector in which innovation comes notoriously slowly. Having a near-monopolistic grasp over finance’s status-quo doesn’t give financial institutions any real impetus to change. 

Despite their apparent benefits, the volatility of popular cryptocurrencies has so far prevented them from becoming a mainstream threat to traditional banking. 

But, what if there was a way to take those benefits, such as privacy, decentralization, user autonomy, and elimination of banking fees, and combining them with the simplicity and stability of established currencies.

Enter the stablecoin.

What Is a Stablecoin?

At a basic level, a stablecoin is a form of cryptocurrency whose value is connected to a stable asset. This asset might be an existing fiat currency, like the Euro or the Dollar, or it might be a physical commodity, like gold or real estate.

As a digital cryptocurrency, stablecoins have no physical presence and are not issued or controlled by governments or financial institutions. They do not require banks or other financial bodies in order to be traded.

The decentralized peer-to-peer nature of cryptocurrencies means they can be traded around the world through instant and anonymous payments. Cryptocurrencies use blockchain and encryption keys to ensure the security of both payment and trader during a money transfer.

What Kind of Stablecoins Are There?

Generally, there are three types of stablecoin:

Fiat-collateralized

Fiat-collateralized stablecoins are linked to an existing currency, such as the U.S Dollar. The company that issues the stablecoin either holds assets of their own or works with a third party who holds assets on their behalf.

The issued stablecoin is essentially a claim on those assets, similar to how cash is used. Fiat-collateralized stablecoins can also make sure of precious metal as collateral.

Generally, fiat-collateralized stablecoins are the simplest to understand and have generated both the most comprehensive adoption and greatest trust from retail consumers.

Crypto-collateralized

Where physical assets or an established currency backs fiat-collateralized coins, crypto-collateralized stablecoins are backed by decentralized crypto-assets. 

The benefit of crypto-collateralized stable coins is that they are entirely decentralized. This means there is no central point of failure, so the entire value of a coin can’t be wiped out due to the loss of a single asset.

The downside of crypto-collateralized stablecoins is that they are still deemed to be inherently unstable by comparison to fiat-collateralized options.

Non-collateralized

Non-collateralized stablecoins maintain their stability through the use of an algorithm. These coins are backed by neither real-world nor crypto assets, but instead are reliant on the idea that coins will generate additional value in the future.

These coins are issued with a bond that promises income should the stablecoin increase in price. Making use of a Seigniorage Shares system, these coins decrease or increase in supply in order to hold their value.

Hybrid-collateralized

Hybrid-collateralized coins use a mixture of crypto-assets and physical assets to create their value. They have the stability benefits of a fiat-collateralized coin and the decentralization benefits of the crypto-collateralized model.

Why Are Stablecoins Important?

Around 1.7 billion adults did not have access to banking services in 2017, according to the World Bank. Many of these unbanked live in developing economies, such as the 225 million unbanked people in China or the 190 million people in India. 

Being unbanked is not an issue restricted to the developing world, however. Around 25% of households in the United States do not have adequate access to banking services.

Stablecoins allow both businesses and individuals to access alternatives to unavailable banking services. 

The use of stablecoins also offers businesses the opportunity to avoid some of the costs associated with cross-border transactions. According to the World Bank, the average cost of remittance in 2020 is around 7%, with the total value of the remittance market standing at $230 billion.

By trading in stablecoins, both businesses and individuals can circumvent the harsh costs imposed by traditional banking institutions.

What Are the Benefits of Stablecoins?

Alongside the clear global access, decentralization, and privacy benefits of a cryptocurrency and the stability of an existing fiat currency, stable coins have a number of other advantages.

Simple International Money Transfers

Transferring stablecoin across the globe through a peer-to-peer network has several advantages over traditional banking methods. 

As with other cryptocurrencies, it only takes a few seconds to transfer coins to a recipient’s wallet, and the owner of the key to the stablecoin wallet is in full control at all times.

Reduced Volatility 

One of the significant roadblocks to the broader adoption of cryptocurrencies has been market volatility. An excellent example of the volatility of the Bitcoin market is the so-called Bitcoin Pizza Day. 

On May 22, 2010, a Florida man paid 10,000 Bitcoins for two large pizzas, valued at around $25. The same amount of Bitcoin would worth around $80 Million today.

This level of market volatility makes it impossible for companies to pay overseas workers, make purchases, or build contracts on the basis of currencies like Bitcoin. Stablecoins offer all the benefits of cryptocurrency transactions without that same volatility.

Rapid Settlement Times

Compared to traditional banking, cryptocurrencies have exceptionally fast settlement times. Sending payment via stablecoin only takes as much time as a standard transaction on the blockchain on which the token was issued. 

For example, the Liquid network can settle any transaction in around two minutes, regardless of time or date. This means payments are not restricted by regular banking hours. 

Lower Fees

As we’ve already mentioned, there are fees associated with both credit card payments, cross-border payments, and remittance. Migrant workers sending remittances home can be charged as much as half a day’s wages just to send the money.

Equally, companies such as AmEx, MasterCard, and Visa charge around a 2 percent processing fee. These costs can be circumvented through the use of stablecoins.

Stable and Automated Escrow

The use of stablecoins enables smart contracts through blockchain. Such smart contracts can automatically and periodically assess escrow conditions without any need for institutional oversight.

Unlike other cryptocurrencies, stablecoins provide a level of price stability to large escrow holdings, which may suffer massive losses in value from crypto-market volatility. Additionally, because such contracts are hosted on blockchain, they are entirely publicly auditable.

What Are Some Common Stablecoins

To give you an idea of what stable coins are available and how they work, here are some of the most popular coins:

USD Coin

USDC, or U.S. Dollar Coin, was launched in 2018 on Ethereum. The coin itself is controlled through a consortium started by crypto-exchange Coinbase and peer-to-peer payment company Circle, called CENTER.

As you might expect, USDC is pegged at a 1:1 basis with the U.S. dollar. The reserve assets backing the coin are periodically audited by the accounting firm Grant Thornton LLP.  USDC is regularly used by traders and investors dealing in developing markets.

DAI

As with the U.S. Dollar Coin, DAI is pegged 1:1 with the U.S dollar through the Maker (MKR) Dai Stablecoin System. DAI’s value is kept stable through cryptocurrency collateral, which is publically viewable on the Ethereum blockchain.

DAI is commonly used in the decentralized finance ecosystem, where the coin’s stability is used to propagate lending and investment.

Tether

Tether was actually one of the first cryptocurrencies to link its value to a real-world fiat currency when it was first launched in  2014. Originally called Realcoin, Tether became the first stablecoin by issuing coins valued at a flat US$1.00.

Because of this early adoption of the stablecoin idea, Tether is now the largest stablecoin in use with the highest market capitalization.

Unlike other stablecoins, Tether is also multi-platform. Having originally launched on Omni Layer, Tether has expanded to  Ethereum, the Liquid Network, TRON, and EOS.

Diem

Diem is the current rebranding of Libra, the original Facebook stablecoin. When the social media giant first unveiled its stablecoin idea in 2019, the plan was to peg it to a basket of established fiat currencies.

Unfortunately, this led to a substantial regulatory backlash, and many of its original members departed. Since then, Libra’s governing body has revised its initial idea and is now looking to launch multiple coins, each linked to a different currency.

The first of these coins, the Diem Dollar, is slated for release at some point during 2021 and has quickly become one of the most anticipated stablecoin releases in the history of this new currency.